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Recession-Proof Yourself

Don't drown in the changing economic tides.

Has the global economic panic put you in a funk? Do you pull the covers a little further over your head with every alarming headline?

"Stocks Plummet on Recession Fears"

"Global Meltdown Panics Investors"

"Toupee Market Collapses; Bald Is the New Blonde"

Seriously, it's no laughing matter if the stock market neutralizes your net worth as it tumbles over a cliff. Here's where a good financial plan can keep you sane. Sticking to these fundamentals can help you stay sound financially during good times and bad.

That's why you shouldn't invest any money in the stock market that you might need for the next five to seven years. That includes your grocery money, your emergency fund, or your high school senior's first year of college tuition. By investing with a long horizon, you give yourself plenty of time to weather the market's cyclical ups and downs -- and especially to recover from the downs. Besides, you don't want to be forced to sell your stock at an inopportune moment because the landlord wants the rent.

But you have to settle for stocks that will go down in a recession. Strong stocks, such as Amazon.com (Nasdaq: AMZN), Apple (Nasdaq: AAPL), and Laboratory Corp. of America (NYSE: LH), may well be able to weather a couple of bad years and still do well for investors. To profit, investors have to do their part and stick around.

Take risks that let you sleep at night. Stocks will go up, and stocks will come down. If this rule has you reaching for a sleep aid, diversify your investments to match your tolerance for risk. Balance your stock investments with safer bets like Treasury notes and bills, bonds, or certificates of deposit. Balance your more volatile stock investments, such as historically risky small-cap and international investments, with less risky dividend payers.

Find the mix that makes you feel comfortable, and then rebalance your holdings every so often to prevent yourself from inadvertently heading into riskier territory.

If it seems too good to be true, it is. Did you try to cash in on tech stocks in the dot-com era with choice investments in Enron and WorldCom? Did you hope to cash in on rocketing home values and end up buying an overpriced, overdecorated McMansion?

Stop yourself the next time you think, "I could cash in on (insert next can't-fail investment fad here)." If you have good reason to think irrational exuberance might be fueling an investing boom, look someplace else to put your money. History tells us those bubbles have a tendency to burst.

Plan for the worst-case scenario. Recessions worry us because companies respond to economic retraction by firing workers. If you're a worker -- and that's most of us -- that's a terrifying thought. If you're living paycheck to paycheck, a pink slip can be the first step toward economic ruin.

Prepare for the worst by building an emergency fund that can cover your regular expenses for three to six months in the event that you're one of those economic casualties. To be extra safe, add money for expenses you'd have to pay out of your pocket, like health-insurance premiums, job-search expenses, and child care.

Let your conscience be your debt guide. Any economic blip has the potential to hurt you more deeply if you're working like a maniac to keep up with your debt payments. Your debts may have grown if you capitalized on boom times to scale up your lifestyle. Give yourself room to breathe by keeping your debt, both good and bad, at a level you can manage in good and bad economies.

Fool contributor Mary Dalrymple likes to pull the covers over her head and sleep in during all economic conditions. She does not own any stock mentioned in this article, and she welcomes your feedback. The Motley Fool's disclosure policy sleeps well at night.